part a cost allocation
TRANSCRIPT
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Cost Allocation
Unit 4
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Learning Objective 1
Allocation of Service
Department Cost
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Department Cost
Producing Departments which include theproduction lines, are the cost accumulation centers inwhich work is performed directly on the goods beingproduced.
Service Departments which include such activitiesas maintenance, personnel, employee services, andthe provision of heat, power and light are necessary for
the entire factory including the producing departmentsto remain in operation.
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Operating Departments
Anoperating department carries outthe central purpose of the organization
The SurgeryDepartment
at Mount
SinaiHospital.
AProductionDepartment
atMitsubishi.
TheGeographyDepartment
at the
University ofWashington.
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Service Departments
Service departments do not directlyengage in operating activities.
TheAccountingDepartment
at Macys.
The HumanResourcesDepartment
at Walgreens.
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Methods to Allocate
Support Department Costs
Single-rate methodallocates costs in each cost pool
(service department) to cost objects (productiondepartments) using the same rate per unit of a singleallocation base
No distinction is made between fixed and variable costs
in this method.
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Methods to Allocate
Support Department Costs
Dual-rate methodsegregates costs within each cost
pool into two segments: a variable-cost pool and afixed-cost pool.
Each pool uses a different cost-allocation base.
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Allocation Method Trade-Offs
Single-rate method is simple to implement, but treats
fixed costs in a manner similar to variable costs. Dual-rate method treats fixed and variable costs more
realistically, but is more complex to implement.
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Allocation Bases Under either method, allocation of support costs
can be based on one of the three followingscenarios:
1. Budgeted overhead rate and budgeted hours2. Budgeted overhead rate and actual hours3. Actual overhead rate and actual hours
Choosing between actual and budgeted rates:
budgeted is known at the beginning of the period,whereas actual will not be known with certaintyuntil the end of the period
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Level to use
Activity Level to Use
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Factors to be considered in the computation of
Overhead Rate
ACTIVITY LEVEL TO USE
In the estimation of manufacturing overhead, as well as theestimation of the base to be used for allocation, it is important todetermine what capacity of production should be adopted.
a. Ideal capacity
b. Practical capacity
c. Master-budget capacity
d. Normal capacity
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Activity Level to Use
a. Ideal or Theoretical is the level of capacity based onproducing at full efficiency.
b. Practical capacity is the level of capacity that reducestheoretical capacity by considering unavoidable operatinginterruptions, such as scheduled maintenance time, shut-downs for holidays and so on.
Note:
Both theoretical and practical capacity measures capacity interms of WHAT A PLANT CAN SUPPLY - availablecapacity. With difficulty, practical capacity is attainable.
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Activity Level to Use
c. Master-budget capacityis the level of capacity utilization
that managers expect for the current budget period, which istypically one year.
d. Normal capacity is the level of capacity utilization thatsatisfies average customer demand over a period (say two
or three years) that includes seasonal, cyclical and trendfactors. This capac i ty is commonly used in thecom putat ions o f overhead rates.
Note:
In contrast, normal and master budget capacity utilizationmeasures capacity level in terms ofDEMAND for the output of theplant, that is the amount of available capacity the plant expects touse based on the demand for its products.
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Predetermined Overhead Rate and Capacity
Calculating predetermined overhead rates using anestimated, or budgeted amount of the allocation basehas been criticized because:
1.Basing the predetermined overhead rate uponbudgeted activity results in product costs that fluctuatedepending upon the activity level.
2.Calculating predetermined rates based upon
budgeted activity charges products for costs that theydo not use.
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Capacity-Based Overhead Rates
Criticisms can be overcome by usingestimated total units in the allocation base
at capacity in the denominator of the
predetermined overhead rate calculation.
Lets look at the difference!
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An Example
Equipment is leased for $100,000 peryear. Running at full capacity, 50,000units may be produced. The company
estimates that 40,000 units will beproduced and sold next year. What is
the predetermined overhead rate?
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An Example
Equipment is leased for $100,000 per year.Running at full capacity, 50,000 units may be
produced. The company estimates that 40,000 unitswill be produced and sold next year.
TraditionalMethod
= $2.50 per unit$100,000
40,000=
CapacityMethod
= $2.00 per unit$100,00050,000
=
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Income Statement Preparation Capacity
Actual volume 40,000 casesSelling price $40.00 per case
Variable production cost $24.00 per case
Fixed manufacturing overhead $100,000 per year
Capacity 50,000 cases
Predetermined overhead rate $2.00 per caseFixed selling and admin. expense $500,000 per year
Revenue 1,600,000$
Cost of goods sold 1,040,000
Gross margin 560,000Cost of idle capacity 20,000
Selling and admin. expense 500,000
Net operating income 40,000$
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Allocation Costs of Multiple Support Departments
DirectMethod
Step-DownMethod
ReciprocalMethod
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Direct Method
ServiceDepartment(Cafeteria)
Service
Department(Custodial)
OperatingDepartment(Machining)
Operating
Department(Assembly)
Interactionsbetween servicedepartments areignored and all
costs areallocated directly
to operating
departments.
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Direct Method An Example
Service Department Allocation Base
Cafeteria Number of employees
Custodial Square feet occupied
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Direct Method An Example
How much of the Cafeteria and Custodial costsshould be allocated to each operating department
using the direct method of cost allocation?
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Direct Method An Example
Allocation base: Number of employees
$360,000 2020 + 30
= $144,000
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Direct Method An Example
Allocation base: Number of employees
$360,000 3020 + 30
= $216,000
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Direct Method An Example
Allocation base: Square feet occupied
$90,000 25,00025,000 + 50,000
= $30,000
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Direct Method An Example
Allocation base: Square feet occupied
50,00025,000 + 50,000
$90,000 = $60,000
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OperatingDepartment(Machining)
Operating
Department(Assembly)
Step-Down Method
Once a servicedepartments costs
are allocated,other service
department costsare not allocated
back to it.
ServiceDepartment(Cafeteria)
Service
Department(Custodial)
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Step-Down Method
Also called the sequential allocation method
Allocates support-department costs to other supportdepartments and to operating departments in a
sequential manner Partially recognizes the mutual services provided
among all support departments
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Service Department Allocation Base
Cafeteria Number of employees
Custodial Square feet occupied
We will use the same data usedin the direct method example.
Step-Down Method An Example
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Allocate Cafeteria costs first sinceit provides more service than Custodial.
Step-Down Method An Example
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$360,000 1010 + 20 + 30
= $60,000
Allocation base: Number of employees
Step-Down Method An Example
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$360,000 2010 + 20 + 30
= $120,000
Allocation base: Number of employees
Step-Down Method An Example
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$360,000 3010 + 20 + 30
= $180,000
Allocation base: Number of employees
Step-Down Method An Example
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New total = $90,000 original Custodial costplus $60,000 allocated from the Cafeteria.
Step-Down Method An Example
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$150,000 25,00025,000 + 50,000
= $50,000
Allocation base: Square feet occupied
Step-Down Method An Example
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Reciprocal or Algebraic Method
Interdepartmentalservices are given
full recognition
rather than partialrecognition as withthe step method.
ServiceDepartment(Cafeteria)
ServiceDepartment
(Custodial)
OperatingDepartment(Machining)
OperatingDepartment
(Assembly)
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This process requires three steps:
1. Express support department costs and reciprocal relationships inthe form of Linear Equations.
2. Solve the set of Linear Equations to obtain the completereciprocated costs of each support department.
3. Allocate the complete reciprocated costs of each supportdepartment to all other departments (both support and operatingdepartments)
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Service Department Allocation Base
Cafeteria Number of employees
Custodial Square feet occupied
We will use the same data usedin the direct method example.
Reciprocal Method An Example
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Cafeteria = $360,000 + .0625 (Custodial)Custodial = $90,000 + .1667 (Cafeteria)
Cafeteria = $360,000 + .0625 ($90,000 +.1667 Cafeteria)= $360,000 + $5,625 + .0104 Cafeteria
= $365,625 / .9896= $369,467
Custodial = $90,000 +.1667 ($369,467)= $90,000 + $61,590= $151,590
Cafeteria Custodial
Machining 33.33% 31.25%
Assembly 50% 62.5%
Cafeteria - 6.25%
Custodial 16.67% -
Reciprocal Method An Example
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Machining Assembly Cafeteria Custodial
Budgeted FO $400,000 $700,000 $ 360,000 $ 90,000
Allocated FO
Cafeteria $123,143 $184,734 ($369,467) $ 61,590
Custodial $ 47,373 $ 94,743 $ 9,474 ($151,590)
Total FO $570,516 $979,477 -7 -
Reciprocal Method An ExampleCafeteria Custodial
Machining 33.33% 31.25%
Assembly 50% 62.5%
Cafeteria - 6.25%
Custodial 16.67% -
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Data Used in Cost Allocation
Illustrations
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Reciprocal Allocation Method (Repeated
Iterations) Illustrated
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Choosing Between Methods
Reciprocal is the most precise.
Direct and step-down are simple to compute andunderstand.
Direct method is widely used.
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End of Unit 4